26 May 2020 - Article
This article, authored by Withers’ James Brockway, was published by Tax Notes on February 10, 2020.
After the publication of substantial proposed regulations for qualified Opportunity Zones (QOZs) in October 2018 and May 2019 and the extensive comments from multiple constituencies, Treasury and the IRS in late December issued final regulations on Opportunity Zones to provide clarity and certainty for investors, developers, and communities. The final regulations and accompanying preamble are extensive and consist of 544 pages. This article summarizes the key points answered in the final regulations and highlights how they differ from the proposed regulations.
The issue of reporting to assess the fulfillment of purposes for the qualified opportunity fund program is under congressional scrutiny. Treasury has declined to weigh in on the argument for enhanced reporting and restrictions on QOF investments, but the IRS has adopted a more comprehensive Form 8996 to gather more information about QOF investments.
Eligible Gain and Section 1231
The proposed regulations provided that only net section 1231 gains (net gains derived from the sale of real estate and depreciable business property) could be invested to obtain QOF benefits. This forced investors with section 1231 gains to wait until December 31 of an applicable year before investing in a QOF. The final regulations adopt a rule that permits the investor to use a gross section 1231 gain for QOF investment within 180 days of the gain recognition event (or later with gain recognized by a flow-through entity as stated below).
Improvement of QOZ Business Property
The statute and regulations require that either the property be original use in the QOZ or that it be substantially improved over a period of 30 months. Substantial improvement means doubling the value of the investment (cost basis) of acquired property but excludes the value of purchased land. The final regulations now permit investors to aggregate improvements made to interrelated properties to satisfy this test as opposed to the previous asset-by-asset approach. Substantial improvement also now includes new property purchased for use in the same business, such as restaurant equipment or hotel furnishings.
Original Use Property and Vacancy
The proposed regulations allowed a property that was unused to be characterized as eligible original use QOZ property only after a period of five years from the time of abandonment. The final regulations reduce the five-year period to one year if the building was vacant for at least one year before the time of the QOZ designation, or three years if abandoned after that time. Property is considered vacant if less than 20 percent of usable space in the property is in use. Brownfield site property is automatically original use property, but funds must be expended on remediation. Also, property owned by local government through foreclosure or condemnation is regarded as vacant when sold or leased by the municipality to the QOF.
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